Gold Bugs Get Cold Feet Over $1225

After spiking to $1226.40 intraday on Thursday the sell off was dramatic. Gold fell sharply to trade at $1200 again shortly after the close after China warned that the rally in gold was a serious bubble.

Peoples Bank of China Governor Hu Xiaolian was quoted as saying that the price of gold was very hoght and the central bank would be careful investing in bubble assets. With gold prices over $1200 an ounce the central banks of the world are about the only institutions that can afford to own it. China has a considerable amount of dollar denominated reserves that it would like to exchange for something not in crash mode like the dollar. Therein lies the problem.

Gold hits its record highs after India purchased 200 tonnes from the IMF. This set the stage for an upward revaluation of gold if India thought it was undervalued enough to spend $1085 per ounce to buy 200 tonnes. Following India's example were central banks in Mauritius, Russia and Sri Lanka. India was rumored to be preparing an offer for what remained of the additional 200 tonnes the IMF still had for sale.

This is where China comes into play. China is actually short gold assets. They have put off buying gold reserves for many months and it was thought that they would rush to step in front of India for the remaining IMF gold in order to avoid being shut out. After all, where else are you going to find 200 tonnes for sale in one spot.

So rumor has it that India is preparing another bid. There are also rumors China is going to buy it. Meanwhile the dollar is crashing and gold prices are going up daily. The gold bugs are positively giddy with excitement to see two super powers entering a bidding war with the IMF. Suddenly China says, "not interested" and one half of the bidding battle evaporates. No bidding war, no higher prices.

Suddenly speculators are stuck holding gold at all time highs and China is waving the bubble flag. Time to sell and gold prices hit the skids. At the same time the dollar is rebounding on the hopes that the jobs report on Friday will be stronger than expected. It is the double whammy for gold prices and sellers appeared in volume.

You may also remember that Barrick Gold (ABX) reported on Tuesday that they had completed buying back their hedges on three million ounces of gold. With that buyback pressure out of the market it simply collapsed under its own weight for a needed bout of profit taking.

Gold Chart

I checked to see if there were any expiration pressures knock the price down but Comex December gold does not expire until Dec-29th so no pressure there.

The GLD ETF reported they added to their holdings again pushing their ownership to 1,131.21 tons. This is very close to the record of 1,134 tons set six months ago just after the March market lows.

The drop to $1200 on Thursday evening appears directly related to the China bubble warning and the reduced odds they are going to buy gold soon. Of course profit taking is always a factor when a momentum trade suddenly loses traction.

GLD Chart

Is this a buying opportunity? Probably so. Remember how fast that dip to $1130 was bought back on Thanksgiving Friday. We have initial support at 1200 followed by stronger support at 1180.